Global FX

US dollar weakness persisted for most of the past fortnight, but the pace of decline has slowed. Some began to question whether the dollar sell off had gone too fast too far. The dollar has lost some 30% against the Australian dollar, 20% against the Canadian dollar and 16% versus the British pound since March. With the global recovery remaining fragile, some still see the dollar as a safe haven play. In contrast, the optimists point to the slew of reports released by governments around the world, including mainland China, as support for the recovery story and therefore justification for further dollar selling.

Looking ahead, the recovery theme is likely to put the dollar under further selling pressure. While the recovery is weak, economic activities in many countries are indeed rebounding. This will put pressure on central banks to gradually withdraw monetary stimulus. On October 6, Australian became the first Group of 20 countries to raise interest rates after the global financial crisis began. Other central banks, including the Reserve Bank of New Zealand and the Bank of Canada also sound increasingly hawkish.

In addition, dollar sentiment will be tested time and again by reports of central banks diversifying foreign exchange reserves away the greenback and using currencies other than the dollar for settling payments for international trade and commodities. The latest IMF data shows that the dollar's share of the world's foreign exchange reserves fell to 62.8% in 2009Q2 from 65% in Q1, while the relative share of the euro rose to 27.5% from 25.9% during the same period. Ten years ago when the euro was first launched, its share was only about 18%.

As the worst of the financial crisis and economic downturn seems to have passed, central banks are adopting different monetary policy stance in their bid to achieve the goal of price stability while avoiding halting a burgeoning recovery.

The Reserve Bank of Australia surprised markets on October 6 with a 25 bp rate hike, becoming the first of the Group of 20 central banks to tighten credit. Minutes of the bank's meeting released on October 20 indicated that the RBA would raise rates further as board members felt that it could be imprudent to maintain a very expansionary policy setting for a long time as it could fuel inflationary pressures. Market is pricing in at least two rate hikes before the year end but we reckon the RBA will be less aggressive. Similarly, New Zealand's central bank is also hawkish as its chief said recently that a rally in the New Zealand dollar was not an impediment to any interest rate rise.

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